Saturday, March 30, 2013

Here are three scary charts about Europe. The scariest comes from three BofA economists, via Wonkblog, which carries the output growth projections. Even the optimistic projections look bleak for Italy and France, and positively catastrophic for Spain.

Zero Hedge points to the rapidly declining bank deposits in the PIIGS and Cyprus (which will soon fall sharply). The crisis is certain to leave deep scars in the banking sector of the peripheral economies.Youth unemployment in Greece and Spain is at shockingly high level, well above 50% and rising. For the Euro-zone as a whole it was 23.8%.

Thursday, March 28, 2013

Econ 101 teaches us that market competition, by enabling efficient price discovery, results in win-win outcomes for both producers and consumers. Alternatively, in the absence of competitive dynamics, markets fail to take off, leaving both consumers and producers worse off.

In this context, this article from FT about the contrasting fates of US and European telecoms market is instructive. It is considered an efficient practice in utility infrastructure to force the network asset owner to share it with competitors for a prescribed fee, most often determined by the sector regulator. This is thought to lower entry costs in such capital intensive sectors and thereby stimulate competition. Accordingly, the India's Electricity Act of 2003 provides for mandatory "open access" of the distribution and transmission network owned by state-owned entities for a fee to private firms for transmitting and distributing their power. The same logic has been applied to unbundling of telecommunication networks. However, even as the European Union aggressively pushed through unbundling in the late nineties, it failed to pass legal challenges in the US. Accordingly, while European network owners were forced to share with their competitors the local loop part of their networks that connect to customers, the US carriers managed to maintain exclusivity and retain entry barriers. If the logic of Econ 101 held, then lower entry barriers and resultant competitive pressures would have boosted the European telecoms market while the absence of the same would have weakened the US market. But the fortunes have been reversed, as the FT writes,

Unbundling has been the single biggest difference between the regulatory environments in the US and Europe over the past decade. The idea was first taken up in the US in the mid-1990s, though the established American carriers managed to block the idea in the courts a decade ago. Their peers in Europe had no such avenue for appeal, forcing them to give new rivals low-cost access to the local loop part of their networks to reach customers. The result: more competition, lower prices and dwindling cash flow. That has been a boon to consumers but, along with the slumping economy, has left network companies badly positioned to finance the next round of network-building.

The contrast with the US could hardly be starker. Over the past five years, the operating cash flow of AT&T and Verizon has risen by a fifth, even as cash flow of the main European players has dwindled. As a result, shares in the two dominant US carriers have risen by more than half since the financial crisis, while their European counterparts have slumped, denting their ability to finance upgrades.

In other words, competition has resulted in market failure. Instead of the "more competition, lower prices, more consumers, more profits, and network expansion", the real-world outcome has been "more competition, lower prices and dwindling cash flow".

The fate of European telecoms market is not an isolated example. Much the same market failures have been a characteristic features of telecoms and airline deregulation in India. In fact, India's telecoms market has evolved in a manner that would have pleased a Chicago economist, but is now facing serious troubles. Instead of the expected win-win outcomes, lower entry barriers and cut-throat competition in both sectors have ended up devastating operators. While consumers have undoubtedly benefited from the lower prices, operators are left without resources to finance expansion and technology upgradation.

This is yet another real-world example of how perfect competition often fails to yield the expected outcomes. In all these markets, once entry barriers get lowered, the size of the market and its long-term potential makes it irresistible for competitors to indulge in price wars. As with winners curse in auctions, such price wars invariably result in a race to the bottom.

The point here is not to convey that competition or deregulation is not desirable, but to caution against any unqualified support for such measures. The dynamics of the market is far too nuanced to be explained away by simplified "invisible-hand" reasoning.

Tuesday, March 26, 2013

India's share of population employed in agriculture has fallen sharply from 60% in 2000 to 51% in 2010 and the pace of decline is set to quicken in the coming years. In addition to transitioning those leaving agriculture, there is the need to accommodate the nearly 12 million people who are expected to join the workforce each year. In most historical examples of such growth transitions in developing countries, industries sector has provided the major share of new employment opportunities.

However, as the Economic Survey 2012-13 highlights, recent trends in industrial employment creation in India has been cause of concern. Even if industry's share of total employment has been comparable to other large Asian countries at similar stage of their growth, its share of gross value added has remained more or less stagnant over the last decade and is far less than that in other countries.

The main reason for this near stagnant share of industrial sector value addition is the low productivity in the sector. This becomes especially pronounced since construction, where most employment is in the informal sector and involves mostly unskilled and semi-skilled workers, has been the fastest growing segment within industry.

In fact, this low productivity trap extends to informal sector economic activity in general. The value addition by a worker in the informal sector is only a small proportion of that in the formal sector for workers in similarly sized firms.

Saturday, March 23, 2013

The obvious attraction of Public Private Partnerships (PPPs) is that it leverages private capital to provide public goods, thereby relieving public finances of atleast some burden. However, an analysis of India's PPP financing reveals that the "private" capital comes mainly from public sources. A 2008 World Bank note had this assessment of the sources of PPP financing,

In 1995–2007 senior debt accounted for 68 percent of project financing on average. The rest took the form of equity (25 percent), subordinated debt (3 percent), and government grants (4 percent), typically “viability gap” grants provided during construction to PPPs deemed economically desirable but not financially viable. Of the senior debt, about 70 percent was provided by commercial banks, four-fifths of this by public sector banks. The rest of the total debt financing came from institutional lenders (around 23 percent), with 5 percent provided by the International Finance Corporation. Bond markets were used sparingly. The use of subordinated debt also remains limited... In recent years the role of senior debt has grown while the share of equity has declined, leading to rising debt-equity ratios

The biggest concerns are the limited role played by bond markets and foreign capital, the two most desired forms of private capital. Another important concern is that the largest source of funding, forming nearly 50% of the total financing, is public sector banks. To put the problem in its perspective, in 2009 bank credit to infrastructure was Rs 2699 billion while the amount raised by corporate bonds was a mere Rs 5.4 billion. These go against the trend in developed and most other developing countries, where private sources and bond markets are the biggest source of capital. India's PPP financing pattern effectively becomes a case of "backdoor public financing".

These trends persist even today. The share of bank finance extended to infrastructure sector as a share of total bank finance has grown from 2.2% in 2001 to 13.4% in 2011. Most banks have reached or are close to their upper limits on infrastructure lending. Given the long-term nature of these loans, asset-liability mismatches are showing up in the balance sheets of all banks. Further, given the environment of crony capitalism that has enveloped larges swathes of the economy in recent years, especially in rent-thick infrastructure sectors, it may not be a surprise if significant share of the loans from public sectors banks are of questionable nature like this.

While the evidence is inconclusive, there are some indications that lenders and developers view grants as substituting for the equity infusion needed during construction. The few projects involving a negative grant—a payment by the PPP to the government—also have a higher ratio of senior debt to equity, suggesting that these payments are being financed by debt borrowed by the PPP project.

Wednesday, March 20, 2013

De-worming has been the poster child of the randomized control trial (RCT) movement in development economics. Its obvious simplicity and cost-effectiveness, apparently validated by numerous RCTs across Asia and Africa, has been highlighted as proof of what evidence-based development policy making can achieve. No serious discussion on evidence-based policy making is today complete without some mention of de-worming. So much so that crusaders are now out to "deworm the world".

In this context, the latest issue of Lancet (pdf here) has some unsettling truths. An RCT of 72 blocks in Uttar Pradesh in India over a period of 5 years, covering over 5000 children in 1-6 year group, conducted by medical scientists, finds that "regular deworming had little effect on child mortality". The randomization was done at the block level, with 4158 ICDS's anganwadi centers in 36 blocks receiving Albendezole tablets twice a year.

Though the main objective of the study was to explore the effect of de-worming on child mortality, its findings on other physical health parameters carry relevance in light of claims made by RCTs done by economists. The graphic below shows that on a host of physical - height, weight, BMI, haemoglobin level - and illness prevalence parameters, there is no statistically significant difference between the treatment and control groups of children. Furthermore, this finding comes despite the treatment almost halving the prevalence of worm infection.

Furthermore, the authors compare the physical health parameters between infected and non-infected students within the control group ICDS centers and report similar findings. In fact, for all worm categories, there is no statistically significant difference in health outcomes between the infected and non-infected child populations.

The main case of the supporters of de-worming is that it prevents students from falling sick frequently and thereby increase their school attendance days. But this study questions the presumption that it contributes to significant health improvements or reduce other disease incidence. Even where worm infection has been halved, it appears to not have contributed to any increase in general physical well-being and lowering of other disease incidence. If this true, how does it square up with the claims of the de-wormers that school attendance increased because of improving child health outcomes and resultant lowering of disease incidence? The authors of the study qualify their findings to "lightly infected" areas, which are more likely in rural areas. But this leads us to what is a "high infection" rate? The "de-worming crusaders" themselves report incidence rates at 16% for Delhi slums and 14% for Andhra Pradesh. But this is just half the incidence rate of the "lightly infected" areas in the present study. Other studies of Kathmandu and Assam, two areas one would suspect of being "high incidence", too point to worm infection rates of 10-25%. If this infection range can be generalized across most of developing Asia, then the findings of the present study becomes immediately relevant. Now, it is possible for the supporters of de-worming to quibble about the small details of any study and dig their heels in. But what cannot be denied is that contrary to anything they claim, there is no unqualified (or so obviously clear) case for universal and prioritized adoption of de-worming on the highfalutin grounds that it is the most cost-effective intervention to improve student attendance. Further, as I have already blogged here, the definition of what constitutes "cost-effectiveness" is certainly flawed. A more appropriate frame of reference for judging "cost-effectiveness" would be the "implementation bandwidth" of public systems. Supporters of de-worming overlook the fact that the limited "implementation bandwidth" of any public system would invariably result in this intervention squeezing the implementation space for all other programs.None of this is to decry or oppose the idea of de-worming. This is only an attempt to temper the claims around de-worming and locate it in its true perspective. It is a note of caution to the prevailing trend of squeezing the last ounce of "academic juice" from a fairly commonplace intervention. In that sense, this post is deliberately written to be similarly provocative, though in the opposite direction, as the "de-worming crusaders".

Tuesday, March 19, 2013

India's civil aviation ministry is considering two proposals - a direct subsidy and a market-based seat-credit trading mechanism among airlines - to boost air connectivity to less-developed markets and remote areas of the country.

The current Route Dispersal Guidelines of the Civil Aviation Ministry mandates all scheduled operators to deploy atleast 10% of their trunk-route capacity on flights to less well-served areas, or so-called category II routes (like northeast, J&K, Andaman, Lakshadweep), and 50% of trunk-route capacity on Category III routes (smaller towns like Coimbatore).

Under the seat-credit trading mechanism, all airlines would be allotted a minimum number of mandatory remote areas connection requirements. Airlines could meet their connectivity deficit by purchasing seat-credits from other airlines who have already met their requirements. Livemint writes,

Under the ministry’s proposed seat-credit mechanism, small air taxi operators can fly to a particular small city destination and earn seat credit that can be sold to a scheduled airline such as Jet Airways or SpiceJet. The bigger carriers will be able to use such credits to meet their requirement of having to connect such remote areas without having to lose money on such operations.

It is reasoned that the seat-credit trading would incentivize small regional air-taxi operators with smaller airplanes to service the small town airports, leaving the more established operators with their regular sized aircrafts to service the bigger towns. The operators themselves or the government would have to establish an exchange which would facilitate efficient price-discovery and trading of seat-credits.

An alternative to the seat-credit trading mechanism is a proposal to encourage regular airlines service the 80 Category-III towns by offering them a subsidy and a monopoly over the route for 2-3 years. The routes could be auctioned off to the airline that would bid for it at the least subsidy. The subsidy would be paid from an Essential Air Services Fund, mobilized from a combination of budgetary grant and a cess on the major route tickets.

Though both these are interesting proposals, it may not be possible to make definitive judgements in favor of either given the complex nature of airline markets in extremely price-sensitive countries like India. However, I am inclined to the latter for the following reasons

1. A direct subsidy suffers from much less information asymmetry. The reverse auction will help transparently and efficiently (atleast better than anything else) identify the amount of subsidy. Once this is done, it is much more easier to administer than the seat-credit trading mechanism. Further, such a subsidy support is likely to help establish the market and also facilitate the integration of these markets to the mainstream. A seats-credit sharing would merely exacerbate the existing market stratification of these areas.

Typically, some risk insurance or viability gap financing is necessary to break open any such market and only governments can finance this. In other words, given the inevitability of such a subsidy support, a reverse auction based direct subsidy may be the least distortionary and most cost-effective subsidy transfer design.

2. The seat-credits model does little to address consumer welfare. Relative to the larger airlines, the smaller air-taxi operators (unless some large players emerge) will have neither the incentive nor the capability to pass on the benefits of an expanding market by way of lower ticket prices. Given the risks involved, it is difficult to imagine airlines operating exclusively on these routes ever acquiring the balance-sheet cushion to lower prices in any meaningful (read market-creating) manner.

3. Lower prices can contribute to sharply increasing volumes, which in turn enables operators to benefit from economies of scale. In the absence of lower prices, these price-sensitive markets are likely to remain stuck up in a low-volume equilibrium. The fact that the seat-credit trading mechanism physically divides the market into two parts, with different operators and their business models, makes a low-level equilibrium a strong likelihood.

4. Finally, there is the Achilles Heel of all trading mechanisms - the initial allocation of mandatory remote-areas connections requirements to each airline. In the absence of a satisfactory process to discover an efficient initial allocation, airlines are more likely to get away with smaller quotas that would be easily met by purchasing from the existing air taxi operators. An efficient initial allocation would have to based on an estimate of the traffic growth in these nascent markets, a highly unreliable exercise at most times. There is also the danger that the seat-credits would end up subsidizing the air taxi operator's traffic expansion that would have happened anyways in the business as usual conditions. As with all such discretionary decisions, corruption can never be far away.

Sunday, March 17, 2013

The FT reports of a number of sub-Saharan African countries rushing to raise foreign currency denominated debt. In September 2012, in a heavily overs-subscribed offering, Zambia raised $750 million as 10 year dollar denominated debt at an yield of 5.625%, lower than Spain sovereign bond yield at that time. Rwanda and Angola have announced plans to raise $350 m and $1 billion respectively, and Nigeria and Ghana too are expected to enter the market.

Unlike Latin America and Asia, Africa has had very few foreign currency denominated bond offerings. Currently, only 13 out of 54 African countries have issued foreign currency denominated debt. Multi-lateral and bilateral financing have formed more than three-quarters of external debts in Africa.
The current interest in emerging market debt has to be seen in light of the global liquidity glut engendered by the ultra-low interest rates in developed economies. With debt market yields hugging the bottom, investors have been looking at exotic markets in search of yields. Even the emerging market bond yields have been falling. Zambia was able to raise debt at such low rates despite its offering being rated "junk" (B+) by S&P.

Predictably, the number of African countries trying to raise foreign currency denominated sovereign debt has led to concerns about its repayment and the "original sin" of a Latin American style potential future debt crisis. The low rates does not tell anything about the risks posed by exchange rate volatility and the country's balance of payments (BoP) position. A depreciating currency would increase the effective repayment rates, while a weak BoP position would strain the repayment capacity.

Zambia, for example, is heavily reliant on Copper, which forms 80% of its export basket. Any volatility in exchange rates will therefore have dramatic effects on its real debt burden. Its currency has depreciated by over 40% against the US dollar since January 2008. Others are similarly exposed, with small variations, to commodity prices and therefore forex market volatility could potentially affect debt sustainability.
Given the widespread governance problems in all these countries, it is important that these debts are for clearly defined objectives. For example, debt raised to finance critical infrastructure investments are more likely to be effectively utilized and compensate the debt cost. In this context, multilateral loans for infrastructure projects can be dovetailed with foreign currency debt. The presence of the multi-lateral lender would not only increase expenditure side discipline, but also serve as a credit enhancement and contribute to lowering of the cost of debt.

Friday, March 15, 2013

The subsidy bill since fiscal year 2004 has grown nearly six times, far more than the growth in the underlying economy in nominal terms. The gross number is even starker: the two Manmohan Singh governments have spent a cumulative Rs.11.82 trillion on various subsidies over the past decade... Subsidies have crowded out spending on public goods. Just ask yourself what could have been built if at least half of thoseRs.11 trillion had been redirected to build new infrastructure... building a kilometre of a good rural road costs aboutRs.5 crore per km, which means that India has effectively given up around 20,000 km of new rural roads, assuming one-tenth of the subsidy spending since 2004 had been used to build new rural roads. One could come to similar conclusions about new schools or drinking water schemes or public toilets... Look at what China has built in the past five years: 19,700km of new rail lines, 609,000km of new roads or 31 airports.

I am in particular struck by the 20000 km new rural roads. This blog has consistently argued that all-weather roads and three-phase electricity supply are the two most effective anti-poverty and development interventions. Furthermore, the absence of all-weather roads attenuates the effectiveness and sustainability of any other development intervention, whereas its presence amplifies their long-term value.

Thursday, March 14, 2013

The OECD estimates that the lack of competition in Mexico cost the country USD 129.2 billion between 2005 and 2009., equivalent to USD 25.8 billion or an annual 1.8% of GDP... This estimates represents the opportunity costs of lack of competition in Mexico. It does not represent the profit or sales of any single firm. The figure is based on an analysis of the economic loss that Mexicans have suffered as a result of paying higher prices than they would have paid in a more competitive market. It also takes into account thee loss suffered by potential users who were deterred by high prices from subscribing to telecommunications services in Mexico.

The econometric analysis is here. In a different context, Acemoglu and Robinson makes the point that Mexico has suffered a big net loss since Carlos Slim's latest net worth is only $79 bn.

Wednesday, March 13, 2013

I've been thinking of writing about this for sometime. Now that I've passed a preliminary muster of Cesar Hidalgo and Ricardo Hausmann's concept of diversified productive knowledge within an economy, and its role in economic growth, I am left with mixed feelings.

Obviously (or so atleast I think) the Atlas has a two-fold agenda. It has brilliantly explored the manifestations of growth, as reflected in the profile of each country's export products and mapped them. It has also quantified the productive knowledge of an economy in terms of the Economic Complexity Index (ECI), and has shown that this is a reliable predictor of economic growth. Its next objective would be to explore what can be done to help countries acquire a diversified base of productive knowledge. I am not sure whether we are covering much new ground here.

1. The Atlas tells us where countries stand on the complexity map and that complexity appears to be a better predictor of economic growth prospects. So what? Standard endogenous growth theories have for long dwelt on the importance of accumulation of knowledge - both product variety/diversification and specialization - as the critical driver of economic growth.

Yes, the Atlas qualifies the character and dynamics of this knowledge. And Hausmann and Hidalgo believe that this "new" information (about drivers of growth), with its close relationship with growth, would help countries, presumably unaware of this, focus on its acquisition.

But I'm not sure whether there is compelling enough evidence - qualified interpretation of existing theories or new evidence - in anything presented by them to convince political leaders and policy makers anywhere to re-visit their prevailing notions about economic growth. However, it does undoubtedly add significant value to the continuous refinement of the endogenous growth models. But that is a matter of interest for academicians and to this small group sitting in Sweden.

2. Even assuming that we have learnt something new, what does it tell about how to get there? What can knowledge about the current level of a country's productive knowledge base and the desired level of complexity tell about the actual path of getting there? In broad terms, this quest is similar to industrial policy regimes followed by many countries that have sought to promote the acquisition of knowledge and technology in specific sectors.

In fact, the decades experimentation on industrial policy, and its mixed results, should itself caution us about the difficulty of any effort at promoting growth with the productive knowledge destination map. Obviously, even when we know our current location and future destination, we still need to know the path and the vehicles to get there. And if the path is itself a dynamic target and we also have to travel in multiple vehicles at the same time, then the quest for destination becomes even more difficult.

3. It finds that diversity of productive knowledge is a more important predictor of growth than even investments in human capital. Maybe. But even controlling for various "observable" factors, we simply cannot quite infer causal relationship between acquisition of diversified productive knowledge and economic growth. The interaction dynamics of the contextual (I am wary of using "institutional"!) factors are too complex to do that with any degree of reliability. It could just be that countries with high ECI scores also had the right environments to acquire that knowledge.

4. Then there is the practical difficulty of its assumptions. Clearly, we cannot expect the numerous small least developed countries like Gabon, Sudan, and Malawi, who are languishing at the bottom of the ECI rankings to do anything much, even in the medium to long-run, to acquire a diversified base of productive knowledge. In an ideal world, the inhabitants of these places should merely migrate to other more habitable locations. In the real world though, their most realistic chance of expedited development lies not in acquiring diversified productive knowledge, but in being able to achieve success with a few sectors.

5. The Atlas points to the relatively low growth potential of the richer natural resource endowed economies, attributing it to their low productive knowledge base. But it can also be argued that given the low economic base from which they started, the natural resources provided them to best and fastest path to economic growth. And atleast some of them grew faster than their other similarly placed colleagues. It is true that many of them have not leveraged that growth to diversify their economies (and expand their productive knowledge), which in turn raises questions about the sustainability of their growth.

While we may claim that once we control for the role of oil, the Middle Eastern economies, with their low productive knowledge base, would have been as backward as any other developing country, it cannot be denied that the people of these countries today enjoy lives which are far better than those in non-resource developing countries, including those with much higher productive knowledge base. If they, like Norway, had used resource windfall to build up a modern economy, we would today have been talking about that as a growth model. There is no reason to lend any more credibility to the productive knowledge base model than one which advocates leveraging natural resources to develop an economic base and then move up the technology frontier.

6. Finally, the Atlas is created using export data. This may be a less reliable proxy for the productive knowledge base of the larger economies, whose domestic economy may contain a diversity of productive knowledge that may not be appropriately reflected in the exports.

Lest we need any more reminders, all "holy grail" explanations of economic growth and development are futile exercises. It all ultimately boils down to exercises in circular logic. Critics will rightly point out that countries lagging behind on diversified productive knowledge base do so because of lack of effective institutions, culture, inadequate investments in human capital, geography, historical factors, weak governance systems, and a series of other factors. Supporters will say that the process of acquisition of productive knowledge will help overcome these other deficiencies. And so on...

Saturday, March 9, 2013

Amidst all the gloom surrounding India's fading economic growth, we risk glossing over the large variance in economic growth rates and quality of governance across Indian states. The fact that many of these states are comparable to large national economies, should alone be enough for us to be more nuanced in analyzing India's economic prospects.

As the recent Economic Survey points out, states like Bihar, Madhya Pradesh, and Maharashtra, have grown in excess or close to double-digit rates. In fact, even as national GDP growth rate slumped to 6.5% in 2011-12, half the states grew at double-digit rates for the 2010-12 period. One of the surprisingly less discussed stories is the remarkable success of state governments in reining in their fiscal deficits, reducing them from 4.1% for 1998-2004 to an estimated 2.1% for 2012-13, and even running a revenue surplus. This stands out in sharp contrast to the fiscal mess that has characterized the federal government. Some of the traditional laggard states have become trendsetters with progressive reforms. A recent article in Forbes summed up the successes,

Gujarat has emerged as arguably the best destination for investors... Bihar and Orissa have pioneered legislation to stamp out corruption. Karnataka is putting gender equality and women’s empowerment at the heart of planning. Kerala, as mentioned earlier, wants to be on par with Nordic nations. West Bengal now allows free movement of goods, having removed checkposts and trusting businesses to be honest. Punjab has introduced a Right to Services Act. The idea is to reduce citizens’ interaction with government officials and subsequently reduce the opportunity for corruption.

A few observations in this context

1. Many of these successes are not built on any of the structural reforms that have been the staple of debates surrounding what needs to be done to get the Indian economy back on track. In fact, all these states have done well on the back of plain simple good governance.

Sure, there are benefits from some of these macro-level structural reforms. But, given the low level of inefficiency equilibrium, there are substantial low-hanging fruits to be plucked by good governance and effective implementation of the existing programs and schemes. It is a pointer to the federal government itself that simple governance reforms can itself dramatically improve outcomes.

2. It is well past time to reform the one-size-fits-all centrally sponsored schemes. Given the varying growth trajectories and requirements of states, such uniform programs are an extremely inefficient use of scarce resources. But instead of reforming or phasing them out, the federal government has in recent years, in deference to populist political considerations, dramatically increased the spending on such programs.

Consider this. The high-profile centrally designed programs NRHM, SSA, NREGA, NRLM, NSAP, IAY, and JNNURM form overwhelming share of financing in critical sectors like health, education, employment guarantee, livelihoods, social safety, housing, and urban development respectively. In other words, the agenda for addressing almost all the major development problems of a state is being framed in New Delhi, leaving the state as a passive recipient of central dole.

Many state governments have even scaled back their local need-based sectoral initiatives to accommodate these central programs. Apart from regular establishment expenditures, state government's own spending in these sectors is now mostly confined to meeting its share of the central allocation or in the complementarities to the national program. The rigid program guidelines, with norms and components, ostensibly aimed at facilitating the achievement of objectives, end up distorting incentives and distracting from addressing the real local problems.

3. Redesigning these programs require reforming the mandate of the Planning Commission itself. It is widely acknowledged that the current process of plan consultations are merely an exercise to annually re-validate the ongoing central schemes. Instead of planning top-down (sic), the Planning Commission should collaborate with the state governments and help prepare need-based state plans. It should provide state governments with the necessary professional expertise in the preparation of such plans.

This would mean dispensing with many of the central schemes and replacing it with sectoral bulk transfers. Such allocations should be made as part of comprehensive sectoral plan with clearly defined outcomes and accountability measures.

4. We need to be careful with the promulgation of nation-wide regulations on economic issues. As the economy diversifies, private sector expands, the role of government changes, and India integrates more with the world economy, there will be the natural technocratic temptation to harmonize regulations to lower transaction costs. We need to be cautious about rushing with hasty legislations.

The need for harmonization, with its attendant benefits, has to be balanced against both political economy considerations and also economic issues arising from asymmetric economic cycles. In this context, TV Somanathan has forcefully argued in this article that proponents of a national Goods and Services Tax (GST) have overlooked important political economy considerations and its impact on the fiscal space available for state governments.

The Eurozone crisis has show that excessive harmonization carries with it considerable economic risks. Harmonization often leaves regions exposed to asymmetric economic shocks without the traditional cushions against the vagaries of the economic cycle. We need to be aware of the need to leave sufficient fiscal and regulatory flexibility that is necessary to effectively manage a continental size economy.

Tuesday, March 5, 2013

Theoretical wisdom on financing infrastructure projects would have it that these long-gestation projects be funded through long-term debt. Such debt is raised primarily from the bond markets since banks are constrained by potential for asset liability mismatch arising from their business model (their deposits are short to medium term, making them borrow short and lend long).

However, India's nascent infrastructure sector growth story goes against this wisdom and relies mainly on bank loans for project funding. The last decade saw a massive increase in private sector investments in infrastructure, especially in power and roads, mostly financed with domestic bank loans. In the wave that swept the sector, many banks lend disproportionately to the sector. This has predictably had the effect of raising concerns about the un-sustainability of bank's exposure to the sector.

Infrastructure is the sector to which Indian banks have the greatest exposure... Among the banks that have significant exposure to the power and infrastructure sectors are Central Bank of India (34% of its loans), IDBI Bank Ltd (32.9%), UCO Bank (32.3%), Canara Bank (22.4%) and Andhra Bank (24.5%)... At least 50% of the highway projects in the rated portfolio scheduled for completion in 2013 have already reported three-six months delays due to land/right of way not being handed over by the concession grantor

The outstanding bank loans to infrastructure projects stood at Rs 6.9 trillion as on 31st December 2012. Of this, Rs 3.8 trillion dollars are to the power sector (mostly generation) alone and Rs 1.26 trillion to road sector. A number of these projects, which are due for commissioning now, are delayed and are likely to request for debt restructuring. The close relationship these projects have with the fluctuations in the business cycle makes debt restructuring even more likely.

Interestingly, both these sectors are very long gestation projects, with returns generated over 23-30 years. Evidently, the most efficient way to finance such projects is through long-term debt. Further, these projects, with distinct project assets and operational contours, are ideally suited for project finance.

The RBI norms stipulate that bank lending to a borrower should not cross 15% of its capital and to a borrower group should not exceed 40%. But most banks have either crossed their sectoral exposure limits to infrastructure or are close to that point. This is important in light of the ambitious $1 trillion infrastructure investment estimates for the Twelfth Five Year Plan (2012-17). Since banks are currently the primary source of funding for infrastructure projects and are close to reaching their lending limits, the source of funds to meet the Plan targets becomes a matter of great concern.

In the circumstances, there are only two other alternatives. One, encourage foreign capital investments in infrastructure. Two, sharply increase the depth and breadth of India's long-term corporate debt market. The second assumes great significance and urgency if we are to have any chance of even achieving half the 12th Plan target. It is also critical to enable banks to securitize and off-load the infrastructure loans from their balance sheet and rectify their unsustainable asset-liability mismatches.

Saturday, March 2, 2013

My latest Governance Agenda column in Pragati talks about the difficulty with enforcing laws in India. It argues that top-down enforcement works at the margins and fails when deviation or violation is the norm and not the exception.